Understanding the tax implications of gifts from covered expatriates is crucial for US persons to avoid unexpected liabilities. Please note that these are the proposed regulations as of today, meaning that the requirements to report and pay the tax have been deferred until the regulations are published in final form.
Who Are Covered Expatriates?
Covered expatriates are U.S. citizens or long-term residents who have renounced their citizenship or terminated their long-term residency. The term 'covered expatriate' is defined by specific criteria outlined in the Internal Revenue Code, including having a net worth exceeding a certain threshold, high average annual net income tax liability, or failing to certify compliance with U.S. tax obligations for the previous five years. For more information on the implications and strategies related to this status, see our guide on how to minimize taxes when renouncing US citizenship or abandoning Green Card.
By meeting any of these criteria during expatriation, an individual is classified as a covered expatriate, subjecting certain transactions involving them to special tax rules.
Understanding Section 2801: The Special Tax
Section 2801 of the Internal Revenue Code imposes a special tax on U.S. persons who receive gifts or bequests from covered expatriates. This tax is intended to prevent tax avoidance through expatriation by ensuring that gifts and inheritances from former U.S. citizens or residents are taxed appropriately. For a comprehensive understanding of the tax implications for gifts from non-U.S. citizens, including covered expatriates, you can refer to our article on US Gift Tax: Are Gifts from Non-US Citizens Taxable in US?
The special tax rate under Section 2801 is generally 40%, applied to the fair market value of the gift or bequest received. This provision ensures that high-net-worth individuals cannot escape U.S. tax obligations simply by renouncing their citizenship or residency.
On September 10, 2015, the Treasury and the IRS issued the regulations. The rules have been in a proposed regulation for almost ten years.
How to Determine Taxable Gifts and Bequests
To determine which gifts and bequests are taxable under Section 2801, U.S. persons must first identify whether the donor or decedent is a covered expatriate. This requires a thorough review of the expatriate's status at the time of the gift or bequest.
Once confirmed, the next step is to assess the fair market value of the gift or bequest. This value forms the basis for calculating the Section 2801 tax. Proper documentation and valuation methods must be used to ensure compliance with IRS regulations.
Exemptions and Exceptions to the Rule
There are certain exemptions and exceptions to the Section 2801 tax. For instance, gifts or bequests under the annual exclusion amount are not subject to this tax. Additionally, qualified transfers for educational or medical expenses made directly to the institution or provider are exempt. To learn more about gift tax exemptions and how they apply to cross-border situations, check out our guide on US Life Time Gift Tax Exemption And US Domicile Concept for Cross Border individuals and their families.
It's also important to note that if the expatriate is not classified as a 'covered expatriate,' the tax under Section 2801 does not apply. Thoroughly understanding these exemptions can help in planning and minimizing potential tax liabilities.
Steps to Ensure Compliance and Avoid Penalties
To comply with Section 2801 and avoid penalties, U.S. citizens should maintain meticulous records of all gifts and bequests received from expatriates. This includes documentation of the expatriate’s status and the fair market value of the received assets.
This rule intends to deter expatriates from leaving their families in the US, but it also encourages the entire family to expatriate. If the regulations become final, one should be aware of the impacts.
It is advisable to consult with a tax professional who can provide guidance on the complexities of Section 2801, help with accurate reporting, and ensure that all necessary tax forms are filed correctly. Proactive measures and professional advice can significantly reduce the risk of penalties and unexpected tax liabilities.
Disclaimer
Tax laws always have exceptions. We aim to provide broad guidance in simple, understandable language. We recommend any reader consult with appropriate paid professionals to obtain tailored guidance after disclosing your facts and circumstances. Our blogs do not provide professional opinions to readers.